EBA Proposals: Differentiation based on a firm’s activities and market profile
The proposed framework is based on a firm’s actual activities, its market presence and risk profile, and to achieve this, the EBA has taken a proportionate approach. Three classes of firms are identified:
- Class 1 – Investment firms that are ‘bank-like’ in structure and risk profile and are deemed systemic or otherwise present a clear risk to financial stability in normal conditions. For these firms, there is unlikely to be any change.
- Class 2 – Non ‘bank-like’ investment firms that are of lesser systemic importance. For these investment firms, the prudential regime being proposed is more tailored to the specific risks that these firms pose to investors and to other market participants.
- Class 3 – Small and non-interconnected firms that warrant a more simplified regime, focused on achieving an orderly wind-down.
In the UK, Class 1 investment firms will typically be the largest players that are currently already subject to PRA prudential supervision.
Class 2 and 3 firms will be differentiated by a series of threshold requirements based upon activity and size considerations. Class 2 will include firms that hold client assets, undertake trading activities or be above certain size thresholds. Class 3 firms would include independent advisors, arrangers and some investment managers.
What will the new prudential framework look like?
The EBA opinion contains a practical, comprehensive and thoughtful analysis of the key components of the current prudential framework. However, whilst a risk-focused and proportionate framework is proposed, it may not reduce regulatory capital requirements for all and indeed, for some firms, the prudential burden may well increase – for example, exempt CAD firms.
Now that the EBA have submitted their opinion, we expect the European Commission to respond before the end of 2017. Implementation could therefore be on the cards for as early as 2018. We therefore recommend that you start the process of working out what category you fall into, modelling the capital you will need and how to plan for any shortfall and what your group impacts are likely to be. We can help you do all of this.
This is hopefully the beginning of the end for the more disproportionate parts of CRD for many investment firms. For non-MiFID investment firms, the FCA may take the opportunity to align its own rules with the EBA’s new approach. Whilst there will be some simplification of prudential compliance for some investment firms, it is not looking like good news for many.
It should be noted that ICAAPs remain an important prudential supervisory tool. If the proposed regime is to achieve its objectives, we expect firms will need to continue to demonstrate that their ICAAPs are a realistic basis for setting more relevant internal capital requirements and Pillar 2 add-ons.
Please get in touch to find out how we can help you prepare for the changes and challenges ahead.